We’ve heard this same old song before. Billyhawk owned a string of Tennessee bowling alleys in a C Corp, Billyhawk Inc; basis zero, FMV astronomical. Mrs Hawk, his wife of 48 years and principal beneficiary of Billyhawk the man and the C Corp, knows from nothing; her business acumen is a gutterball.

So she and her advisors, attorneys and accountants hawk the alleys via Hansell, a bowling alley broker with nationwide connections (you can’t make this stuff up). Hansell finds la famille Corley, New England bowlerini of vast experience, who are willing to fling boatloads of USD at the C Corp. Mrs Hawk loves it, until she hears about double taxation, capital gains, estate taxes and other disturbers of the sleep of the righteous distributee.

Hansell offers a solution. How do you spell “MidCoast Financial”, friend of the zero-basis, cash rich C Corp? And how do you spell “here we go again”? See my blogposts “Substance Matters”, 3/1/12, and “A Good Day for Taxpayers”, 3/15/11.

MidCoast swears they’re getting the cash to buy all the Billyhawk Inc stock from their own and borrowed funds, but there’s no proof of this, and MidCoast avers it will operate Billyhawk Inc. for the foreseeable future, laying off short-term capital losses against tax from the sale of the bowling alleys to la famille Corley, which MidCoast will close and leave the cash in Billyhawk Inc. Needless to say, MidCoast strips Billyhawk Inc. of the cash, does a phony Danish kroner mix-and-match forex deal with its trusty offshore (see my blogpost “An Option Isn’t a Contract”, 4/14/11), and when IRS challenges the deal, waltzes away into the sunset, pursued by DOJ brandishing handcuffs and breathing fire and slaughter.

Of course, Section 6901 transferee liability rains down upon Mrs Hawk and the hawklings near and far. The IRS yells “intermediary transaction”. MidCoast gave the hawklings the Corley boodle less whatever rake-off (not referring to a certain USDCSDNY Judge; he’s a different Rakoff) MidCoast got for facilitating these shenanigans. MidCoast did nothing but play ring-a-ring-a-rosie with the Corley cash, says IRS, and Mrs Hawk and the hawklings made a fraudulent conveyance of the Billyhawk stock to MidCoast to defeat, delay, defraud, vex, harass and swindle the United States Treasury, its lawful creditor.

Mrs Hawk and the hawklings seek summary judgment. They shower Judge Wells with affidavits proclaiming the bona fides with which they acted, the due diligence they pursued, with attorneys and accountants checking references, doing research and all that jazz.

But summary judgment is a hunt for disputed facts, and Judge Wells finds a biggie. Although the hawklings swear MidCoast got funds to close the purchase of Billyhawk Inc from Mid-Coast’s own monies and a private loan from an offshore, and didn’t strip Billyhawk Inc’s proceeds from the sale to Corley, they don’t have checks, bank statements or anything else to prove it. Every payment to the hawklings came out of MidCoast’s attorneys’ escrow account. If MidCoast did get outside funds, then Billyhawk Inc wasn’t rendered insolvent when the hawklings got the boodle, as the Corley cash was still aboard, so no fraudulent conveyance. But if there was the ring-a-ring-a-rosie with the same money, namely, the Corley cash, then Billyhawk Inc was rendered insolvent when the hawklings and MidCoast chopped the pot, and there might be a fraudulent conveyance, depending upon the facts and circumstances (strike up the band, Eddie Elgar). So there must be a trial.

No there mustn’t, says IRS, at least not yet. We need a continuance, stay, time out on the field, if there’s going to be a trial here. There’s a criminal investigation going on into MidCoast, and we can’t permit the defendants to use the liberal civil litigation discovery proceedings, such as we have in Tax Court, against the government, which could torpedo the investigation.

The hawklings squawk that they’re not the subjects of any criminal investigation, MidCoast isn’t a party here, and IRS is just stalling, hoping for some evidence to fall from the sky and bail them out of their losing litigation.

Judge Wells: “… petitioners are not targets of the criminal investigation of MidCoast. Respondent’s (IRS) contention that the testimony of certain MidCoast employees might be inhibited by the criminal investigation is, at this stage, purely conjectural. Moreover, respondent’s contention is at odds with the undisputed fact that, in other cases involving MidCoast, respondent has taken the depositions of numerous MidCoast employees, including the individuals who served as MidCoast’s president, general counsel, and controller during 2003. We conclude that the criminal investigation of MidCoast does not warrant a stay of the instant proceedings at this time. Accordingly, we will deny respondent’s motion for a stay of proceedings.” 2012 T. C. Mem. 154, at pp. 23-24 (Footnote omitted).

You know the rest. Now so do Joseph Mohamed, Sr. and Shirley Mohamed, generous of spirit but failures at tax preparation, in the eponymous case, 2012 T.C. Memo. 152, filed 5/29/12. And this follows up on a current discussion in one of the LinkedIn tax blogs I subscribe to.

Joe and Shirl generously funded a Charitable Remainder Unit Trust (CRUT), properly set up and compliant. Instead of paying a few bucks to an EA or a CPA, they funded the CRUT over two tax years with $20 million worth of property (which the CRUT sold at arms’-length, and which yielded prices above what Joe and Shirl claimed on their 8283s), and prepared their own tax returns, with home-made 8283s.

Like my old law school icon, “the jolly testator who makes his own will”, Joe was a do-it-yourselfer and only read the 8283 form, never bothering to read the instructions. The Form 8283 in use for each of those years only spoke about appraisals for works of art in excess of $20K. OK, says Joe, I don’t need no stinkin’ appraisals, I’ll just be conservative in my guesses on the 8283s.

Judge Holmes delivers the bad news. The regulations are clear, the statutory delegation to the Sec’y of the Treasury to make regulations is clear, and the instructions are clear; reliance on the form alone won’t help you, and Joe, you’re not in substantial compliance. Your appraisals are too late, and one of them would be insufficient even if it were timely. That the properties sold in the aggregate at more than you claimed is great for the CRUT, but helps you not at all for the current deductions.

Judge Holmes, The Great Dissenter, the Judge who writes like a human being, and lately the Terror of the D.C. Circuit (see my blogpost “Judge, He Didn’t Mean It”, 5/17/12), tells the sad tale: “The Mohameds make one last-ditch effort to save their deductions. They point out that the Commissioner’s Form 8283 for 2003 and 2004 didn’t indicate anywhere on it that a taxpayer had to get an independent appraisal for contributions worth more than $5,000 and presented conflicting messages about what could be filled out by the taxpayer and what required an appraiser’s signature. We won’t try to explain away these difficulties, and note that the Commissioner has since changed his form to reduce confusion. Although sympathetic to the Mohameds’ cause, we can’t hold the form’s failings against the Commissioner here, because ‘the authoritative sources of Federal tax law are in the statutes, regulations, and judicial decisions and not in such informal publications.’ A taxpayer relies on his private interpretation of a tax form at his own risk.” 2012 T. C. Mem. 152, at p. 25 (Citations omitted).

So Joe and Shirl saved maybe a grand or two in tax prep fees, and lose deductions for $20 million worth of property demonstrably donated to a bona fide CRUT at FMV, plus legal fees, plus interest.

Well, those were the words of the immortal Keith Richards, with an assist from Mick (The Mouth) Jagger, in their 1967 hit, so entitled. But yesterday’s papers (or rather blogs, e-blasts and sundry cybernetic emanations) did have one piece of news some people might fall upon with glee.

As long as IRS has not nailed the alleged employer for IC-ing an EE, that person or entity can participate in the Voluntary Classification Settlement Program, if the employer has consistently treated the now-to-be reclassificados as ICs until now, has filed all the 1099s for whatever he/she/it/they paid the reclassificados for the last three years, and is not currently under audit by State or Federal agency, or if audited in the past, is in 100% compliance with the results of such audit currently.

And it’s not all or nothing: the putative employer can volunteer for some, and await the draft for the others. If asked, I would strongly suggest, in Jack Lawrence’s immortal words in the Frank Sinatra 1939 hit, “All or Nothing At All”, that the employer reclassify the whole corps de ballet. You have placed yourself on the radar; and note the extended SOL in Form 8952, so be well advised.

Query-If a putative employee has dropped an SS-8, SSA has asked for information in response but time for responding has not yet run out, is the alleged employer “under audit”? Stay tuned.

State and municipal governments and not-for-profits can apply, if otherwise eligible (and a Form 990 audit knocks you out of the box, so beware).

The good news is that the volunteer gets a bye on past years’ FICA-FUTA indiscretions, if they pay the last year’s tax at a special discounted rate (for special friends of Doug Shulman, they have a special discount; see IRC §3509(a) and instructions to Form 8952). They must agree to keep open the SOL for each of the three years going forward, so IRS can see that they’re being good children and not backsliding.

Check out Announcement 2011-64. And Prime West, who made a guest shot on my blogpost “The Wichita Linewoman”, 5/23/12, please copy; you might want to join in now. Even if there is a rush.

To adopt the title of Erich Maria Remarque’s 1928 classic war novel, there are two Tax Court cases today, 5/24/12, but they both tell the same story–no substantiation means no deductions. Oh yes, and you should file tax returns timely and report all income. So all quiet on the tax front.

Well, she was in California, and didn’t work for the County, but the old Jimmy Webb song that Glen Campbell made a hit in 1968 ran through my head as I read about the plight of Kathleen Murray, a/k/a Kathy the Cable Girl, 2012 T.C.Sum. Op. 49, filed 5/23/12. It’s another Section 7463 “so what?” case, but the unreimbursed employee business deduction angle makes it interesting.

Kathy started as a horse trainer, complete with a Sundowner Stampede horse trailer and a Dodge 3500 to pull it, but then met up with the Cable Guy (no, not Larry; Ernie Helm, known as Ernie the Cable Guy, hereinafter ETCG). ETCG convinces Kathy to stop training ponies and splice up with him (no, not that kind of splicing–splicing telephone wires).

They both worked for Prime West, an entity that connects things to other things, specifically telephone lines to add telephone and data services to people and businesses. ETCG and Kathy were employees of Prime West, and usually worked the same district. ETCG taught Kathy the trade.

Prime West supposedly leased Kathy’s trucks, and a van she owned, and certain tools she needed (not all cable can be spliced the same way with the same tools), and paid Kathy a flat hourly lease rent for all of them. But, says STJ Lew Carluzzo: “Prime West did not require petitioner to substantiate the actual expenses incurred for the use of her vehicles or tools, and she was not required to return to Prime West payments made pursuant to the equipment lease that exceeded her costs.” 2012 T.C.Sum. Op. 49, at p. 7.

Sound like a non-accountable employee expense reimbursement plan to you? It did to Judge Lew, lease notwithstanding. Also notwithstanding that Kathy reported her lease rent and expenses on a Schedule C. Also notwithstanding that she got a 1099-MISC for her lease rent.

Judge Lew disposes of the employee-independent contractor issue in four sentences (and it really doesn’t need more on these facts): “Petitioner was not engaged in an equipment rental trade or business independent of her employment with Prime West during any of the years in issue. Furthermore, there is nothing in the record that remotely connects the rental fee agreed upon in the equipment leases to the fair rental value of the equipment subject to those leases…. The form of the equipment leases notwithstanding, in substance the equipment leases represent Prime West’s program to reimburse its cable splicer/employees for expenses incurred in connection with their employment. For Federal tax purposes, the substance of a transaction takes precedence over the form of the transaction.” 2012 T.C. Sum. Op. 49, at p. 22.

Section 274 exactitude puts paid to most of Kathy’s vehicle expenses; she has no log, her oral testimony is inexact (she claims fuel and similar expenses for a month when she agrees she wasn’t working) and so she’s disconnected from strict substantiation. While a van she used might be exempt from Section 274 strictures, as it is a non-personal use vehicle, Kathy has insufficient substantiation even for the Cohan standard.

Now if whatever expenses she is allowed (and there isn’t too much, a GPS device and a digital camera she used to photograph her splices, which Prime West needed her to provide, utilities for a garage she used part of one tax year, some tools she bought and a storage unit she rented) were in fact deductible as unreimbursed employee business expenses, Kathy took the standard deduction and never itemized, so those expenses are lost.

But Judge Lew follows in the footsteps of The Great Dissenter, Judge Holmes (see my blogpost “The Busted Stipulation”, 1/27/12), and deftly ducks the issue. Judge Lew goes The Great Dissenter one better, and ducks in a footnote: “As noted, petitioner did not elect to itemize deductions for 2004 and 2005. Following the parties’ lead, we ignore the requirement that unreimbursed employee business expenses, if otherwise deductible, must be deducted as a miscellaneous itemized deduction pursuant to an election made on the taxpayer’s return. See sec. 63(e); see also Jahn v. Commissioner, T.C. Memo. 2008-141, aff’d, 392 Fed. Appx. 949 (3d Cir. 2010). Of course, itemized deductions allowed in this proceeding would be in lieu of, rather than in addition to, the standard deductions claimed on petitioner’s 2004 and 2005 Federal income tax returns.” 2012 T.C.Sum. Op. 49, at p. 11, Footnote 2.

And the parties can sort out whether to take the standard, or itemize and take the miscellaneous itemized above the 2% AGI floor, in the Rule 155 which will follow.

Kathy had a CPA do her taxes and told the CPA the whole story, so “gude faith, he maunna’ fa’ that”, as Scotland’s greatest remarked, and Section 6664(a) rescues Kathy from the Section 6662(a) penalty IRS wanted to splice onto Kathy’s bill.

I was asked by a reader for the particulars of the treatise I mentioned in my earlier blogpost this date (5/22/12), “A Book and a Modest Proposal”. The book is entitled “Practice and Procedure in the U.S. Tax Court”, by Prof. Danshera Cords, published by Civic Research Institute, Inc., Kingston, NJ 08528, copyright 2012. Note that I have not read this work, so I can neither review nor recommend it. Nor do I receive any compensation for mentioning it on this blog.

And so the Biblical encomium of Genesis 32:28 is bestowed upon Michael J. Dale, in the eponymous T. C. Mem. 2012-146, filed 5/22/12. Except for $71, that is; he loses that one.

Mike said he was an innocent spouse. His loved-once, Big Ellen, invested in a cattle shelter run by one Hoyt. IRS blew up the shelter, and SNODs rained on the heads of the non-cowboys caught in Hoyt’s stampede. IRS said Mike was no innocent, but on the eve of trial IRS conceded Mike satisfied Section 6015(c)’s version of blamelessness.

Mike wanted a Section 7430 prevailing-party expense allowance of $4998.50; IRS agreed to $4927.50, but objects to $71 for “secretarial and clerical work performed by a secretary ($37.50), an assistant ($23) and a ‘staff’ member ($10.50).” 2012 T. C. Mem. 146, at p. 3.

So Mike goes to Tax Court for the $71. You gotta like a guy that fights as a matter of principle. And his counsel: one has to ask if she was getting paid.

But Mike loses. Section 7430(c)(1) reimburses for lawyer’s work, and the cost of secretarial and like services (lawyer’s overhead) is usually built into the lawyer’s fee.

Judge Kroupa: “Here, the titles of the persons who performed the services are immaterial. Rather, the nature of the services performed is relevant. The fees at issue relate to routine administrative tasks (e.g., editing or scheduling) and not to the performance of legal services (e.g., drafting legal documents). Petitioner did not demonstrate that the fees at issue were for work akin to that of an attorney. Accordingly, petitioner is not entitled to recover the fees at issue.” 2012 T.C. Mem. 146, at pp. 4-5.

But fighting for $71 definitely puts Mike in the premier litigants’ division.

A new treatise on Tax Court law and practice has been written by Prof. Danshera Cords, of Albany Law School. I haven’t read the book, so I can neither review it nor recommend it, but I am glad that someone has written about the minefield that is Tax Court practice. Too many litigants and practitioners, even those with decades of litigation experience and a list of high-profile successes (cf. F. Lee Bailey, Esq., 2012 T.C. Mem. 96, filed 4/2/12), have taken some nasty falls there.

Now I’ve said more than once, this is not a political blog; I grind no axes here. But on a non-partisan note, I must say that the Tax Court system is broken and needs repair. Prof. Cords has taken a step, but there is much more ground to cover.

Far too often practitioners are unaware of the Byzantine, not to say labyrinthine, limitations on Tax Court jurisdiction, scattered in various IRC sections in a masterpiece of counterintuitive logic. Even employees of IRS misinform taxpayers, mistakenly sending them to Court of Federal Claims or United States District Court, where they encounter a Sargasso Sea of procedural doldrums until the SOL runs on their meritorious claims (cf. Murray S. Friedland, 2011 T.C. Mem. 90, filed 4/25/11).

Finally, and most importantly, any attorney who has been “admitted to practice before and is a member in good standing of the Bar of the Supreme Court of the United States, or of the highest or appropriate court of any State or of the District of Columbia, or any commonwealth, territory, or possession of the United States”, (Tax Court Rule 200(a)(2)) is eligible to be automatically admitted to practice before Tax Court. The attorney need show no proficiency in Federal practice (to say nothing of Tax Court practice), or even the vaguest acquaintance with the IRC.

All other applicants for admission (and IRC Section 7452 permits anyone to apply for admission) must take an immensely complex examination, the pass rate for which is well below that of any State’s bar examination. Its complexity and scope, as to the years for which questions were available, certainly outdid the Special Enrollment Examination, which I passed.

But when I applied to take the Tax Court admissions examination, after months of study, my application was rejected, Judge Whelan informing me that as an attorney I could not take the examination, but for payment of a modest fee I could be admitted.

Hence the number of pro se litigants before Tax Court. Attorneys are expensive; there is no meaningful competition, as all but the infinitesimally chosen few are precluded from appearing, notwithstanding the brave language of IRC Section 7452: “No qualified person shall be denied admission to practice before the Tax Court because of his failure to be a member of any profession or calling.” Yeah, right.

So Congress and Tax Court, I have no doubt that between the two of you there lies a solution to providing less expensive and more competent representation to Tax Court litigants.

I wouldn’t waste my time, or my readers’ time (both of them), on a case like Sean Devlin, 2012 T. C. Mem. 145, filed 5/21/12. It’s the usual tax protester’s cocktail of frivolity, but Sean gets a boost from IRS’ failure to build a good trial record.

Sean didn’t bother to file five years’ worth of returns. IRS prepared SFRs and sent Sean a SNOD for the first of the five years, by certified mail, to a Long Island, New York address. This was returned as undeliverable. Two years later, IRS sent SNODs for the other four years to an address in Reno, Nevada, by certified mail, and those were not returned.

Sean never petitions Tax Court to contest his liabilities as stated in the five SNODs, so IRS sends Sean Letter 3172, a Notice of Federal Tax Lien Filing and Your Right to a Hearing Under IRC 6320. Apparently this got to Sean’s current address, and Sean seeks a face-to-face.

Sean petitions Tax Court, claiming he never had a chance to contest liability. He’s right as to Year One, as IRS concedes the Long Island, New York address was not Sean’s last known address, but the Reno, Nevada letters were duly mailed (and IRS has Forms 3877 to prove it), and Sean never petitioned or appealed.

Ordinarily, the presumption of regularity would sink Sean despite his protestations of non-receipt. But the trial record is not of the best. Judge Vasquez: “We find nothing in the record that connects petitioner with 6110 Plumas [Reno]. As late as December 6, 2004, the IRS was mailing correspondence to petitioner at 3 Huskel Lane, Smith Town, New York[Long Island]. Although it is possible that after that date and before February 2, 2005, the date the IRS mailed the notices of deficiency for 2000 and 2002, the IRS received an information return or other document showing petitioner’s address to be 6110 Plumas, there is no evidence of this. Additionally, nowhere in Settlement Officer X’s declaration, respondent’s pretrial memorandum, or respondent’s posttrial brief is there anything to show that 6110 Plumas was petitioner’s correct address during 2005 and 2007. Accordingly, the presumption of proper mailing is not raised, and there is insufficient evidence to show that petitioner received the notices of deficiency for 2000, 2001, 2002, and 2004. We therefore allow petitioner to challenge his underlying tax liabilities for the years at issue.” 2102 T. C. Mem. 145, at pp. 8-9 (Footnotes and name omitted).

If IRS prepared the SFRs from 1099s or W-2s or K-1s, and had put those in evidence, then the address shown on those would substantiate the “last known address” of the elusive Sean. But none of those are in evidence.

Likewise, “In a number of recent cases the Court has found a taxpayer to have received a notice of deficiency despite a claim to the contrary. In these cases, however, the taxpayer either did not argue that the notice of deficiency was mailed to an improper address or did not unequivocally deny under oath receiving a notice of deficiency, or the evidence showed that the notice of deficiency was mailed to the correct address. See, e.g., Diamond v. Commissioner, T.C. Memo. 2012-90 (properly completed Form 3877 showing taxpayer’s correct address raised the presumption of proper mailing and allowed the Court to find that the taxpayer received the notice of deficiency after he refused to deny receipt under oath); Kamps v. Commissioner, T.C. Memo. 2011-287 (taxpayer argued only that he did not receive the notice of deficiency, not that it was mailed to the improper address); Clark v. Commissioner, T.C. Memo. 2008-155 (taxpayer presented no evidence that he did not receive the notices of deficiency and did not contest that the notices of deficiency were mailed to his correct address); Bailey v. Commissioner, T.C. Memo. 2005-241 (‘[p]etitioner does not dispute that the notice of deficiency was mailed to his last known address, and he does not unequivocally deny that he received it’). None of these scenarios is present in the matter before us.” 2012 T. C. Mem. 145, at p. 9, footnote 8.

So Sean gets a chance to disprove IRS’s asserted liabilities. But Sean just goes frivolous again. So Judge Vasquez sustains IRS, and shows Sean the Section 6673 yellow card. Further frivolity will cause the wrath of Tax Court to descend upon Sean heavily.

But IRS trial counsel, a word to the wise. When you get the SNODs, get the back-ups as well and put it all in at trial.

Jack and Joan had a Sub S for their various rental properties, and had filed 1120s for the 19 years of the Sub S’s existence, during which time they dwelt in rented premises. Seeking to avail themselves of Congressional largesse in the form of the Section 36 FTHBTC2, they bought a dwelling in a State with no state income tax, contributing $7500 of their own cash while their Sub S graciously chipped in $319,500 and took title. Jack and Joan claimed the Section 36 credit, and the Sub S did not.

But pass-through entities are not individuals, and even though Jack and Joan might have qualified if they took title themselves, Congress meant for their largesse to be sufficiently guided so as to fall into the laps of individuals only.

Judge Kroupa: “We hold that S corporations are not individuals for purposes of section 36. A corporation, at its core, is a business entity organized under State or Federal law, whether an association, a company or another recognized form. A corporation that satisfies certain criteria may elect small business status for Federal income tax purposes. An S election does not alter the corporation’s corporate status; it merely alters the corporation’s Federal tax implications. Items of income, deduction, loss and credit generally pass through to the shareholders. S corporations remain freestanding entities ‘independently recognizable’ from their shareholders.” 138 T. C. 22, at p. 4-5 (Citations omitted).

Section 36 mentions “individuals” 36 times, corporations zero times, says Judge Kroupa (huzza for the “global search” function!). Corps do not have principal residences, they have principal places of business. Individuals have their own Title in the IRC, and corps have their own as well. Never the twain shall meet.

Jack and Joan claim an IRS employee told them they could do it. Too bad, says Judge Kroupa, but the law is the law. “Petitioners seek leniency by arguing that IRS representatives indicated that they could claim the tax credit if the property was purchased through the S corporation. It is unfortunate when a taxpayer receives inaccurate information. We have recognized, however, that incorrect legal advice from an IRS employee does not have the force of law and cannot bind the Commissioner or this Court. Ultimately, statutes, regulations and judicial decisions govern a taxpayer’s tax liability. “ 138 T. C. 22, at p. 7 (Citations omitted).

So Jack and Joan are thrown out at home.

And so are Felix Rospond and Loretta Rospond, 2012 T. C. Sum. Op. 47, filed 5/21/12, a “not for nuthin’” Section 7463. Felix and Lorie formed a New Jersey LLC to hold family assets, bought their house in the aforesaid LLC (which had the fetching name of Jacco Associates, LLC) , and claimed the FTHBTC2.

Same result from Judge Wells, who doesn’t cite Judge Kroupa’s decision in Trugman, supra, but has a bushel basket full of cases and rulings wherewith to beat up Felix and Lorie. Pass-through or disregarded, if it isn’t an individual taxpayer’s principal residence, no Section 36 credit.

An author, teacher, advocate and trusted advisor, Lew Taishoff is a New York City-based attorney with 52 years of experience in corporate and individual tax and real estate matters. He is an Enrolled Agent, examined and admitted to practice before the Internal Revenue Service, and admitted to practice before the ... Continue reading →